American Vanguard's (AVD) CEO Eric Wintemute on Q2 2014 Results - Earnings Call Transcript

Aug. 2.14 | About: American Vanguard (AVD)

American Vanguard Corporation (NYSE:AVD)

Q2 2014 Earnings Conference Call

July 31, 2014 04:30 a.m. ET

Executives

William A. Kuser – Director of Investor Relations and Corporate Communications

Eric G. Wintemute – Chairman and Chief Executive Officer

David T. Johnson – Chief Financial Officer and Principal Accounting Officer

Analysts

James Sheehan – SunTrust Robinson Humphrey

Brett Wong – Piper Jaffray

Daniel Rizzo – Sidoti & Company

Bruce Winter – Private Investor

Operator

Greetings, and welcome to the American Vanguard Second Quarter 2014 Conference Call and Webcast. (Operator instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Bill Kuser, Director of Investor Relations. Thank you, sir. Please begin.

William A. Kuser

Well, thank you very much, Royia, and welcome everyone, to American Vanguard's second quarter and mid-year earnings review. Our speakers today will be Mr. Eric Wintemute, the Chairman and CEO of American Vanguard; and Mr. David Johnson, the company's Chief Financial Officer.

Before beginning let’s take a moment for our usual cautionary reminder. In today's call, the company may discuss forward-looking information. Such information and statements are based on estimates and assumptions by the company's management and are subject to various risks and uncertainties that may cause actual results to differ from management's current expectations. Such factors can include weather conditions, changes in regulatory policy, competitive pressures and various other risks that are detailed in the company's SEC reports and filings. All forward-looking statements represent the company's best judgment as of the date of this call and such information will not necessarily be updated by the company. With that said, we will turn the call over to Eric.

Eric G. Wintemute

Thank you, Bill, and thank all of you for joining us this afternoon. We will be keeping our prepared marks brief today since we provided a business update just 10 days ago. I would like to reiterate a few points, allow David to comment on some of our specifics that appear in our 10 Q, and then we will take any questions you may have.

First let us discuss revenue. Primary driver for our reduced year-over-year performance is the sale of our US corn products. Sales into other markets such as potatoes, cotton, peanuts, vegetables, fruits from both our international and non-crop businesses are all performing well. However, our US corn business has suffered from the much discussed below normal purchasing in the Midwest distribution channel.

As we indicated in our previous call, we have devoted considerable effort to investigating and analyzing channel inventories, and believe that we have far better visibility on this issue. It is clear that after significant drawdown of excess inventories in the first half of 2014, channel inventories more closely resemble normal levels. Although we do have an overhang in a couple of SKUs with a few distributors. Overall, we expect to see our revenues improve sequentially. As the third quarter unfolds, we are forecasting a modest increase in sales above our second quarter level. This should be followed by a more significant increase in the fourth quarter as early purchases commence for the 2015 planting season.

Second let us discuss profitability. The primary reason for our reduced gross margins this year relate to our throughput in our manufacturing facilities. As we have indicated, elevated channel inventory levels and our own internal inventory levels have compelled us to throttle back on manufacturing production. As a result of this reduced utilization rate, recovery of fixed factory cost has declined, and consequently these unrecovered costs are deducted from our income statement in the quarter that they occur. David will reiterate some of the actions that we are taking to improve our manufacturing efficiencies and address the impact on our profitability.

With those comments, I will turn the call over to David.

David T. Johnson

Thank you, Eric. Good afternoon. Eric has already covered the shortfall in net sales for the three and six month period, which were all corn related. I’m going to focus on the key areas of our financial performance, including our dropping gross profit, our increased inventory levels, factory cost and increased under-recovery of this cost, our progress on controlling operating expenses, our net income and finally our cash position.

During my comments I intend to cover the main questions raised by callers at the time of the business update on July 21. Our net sales overall are down 21% in the quarter and 28% year-to-date, pretty much all driven by reduced sales of our corn products. The lower sales are driving reduced gross profit dollars. You will read in the Form 10-Q which we are filing today that we are reporting gross profit dollars down from $42 million last year to $26 million. About 70% of reductions is volume and price mix related. The remaining 30% is driven by increased under recovery of factory costs, because we have made the deliberate decision to hold down manufacturing in the factories and accepted short-term reduced profits as a consequence.

When you look at this from a gross margin percentage point of view, our gross margin performance for the quarter is down 10% as compared to last year, 2% of which is product, price mix driven and the balance is increased under recovery of fixed factory costs. As you will have read in our earnings release, our inventory at the end of the quarter was $175 million, which represents an increase over and above the March 2014 closing position and is also above the historical normal levels for this time of the year.

Inventory management is a complex issue and in the case of corn includes taking into account both channel inventory, which we do not own and our in-house AMVAC inventory. As we have mentioned, we believe that channel inventory of our corn products have been drawn down to more normal subtle during the 2014 season. This should create the headroom necessary for improved sales of our corn products into the 2015 growing season. The timing and degree by which we can reduce AMVAC inventory will depend on the strength of the corn market in the new planting season. That will likely kick in during Q4 of this year and Q1 of 2015.

Furthermore, we are spending a lot of time working with our operations team on inventory levels, and we expect to see additional receipt of long lead time during Q3 that will result in further modest increases in inventory. Then the same should stop the decline in Q4 as we get closer to the 2015 planting season.

As we have disclosed on numerous occasions, controlling our inventory balances in the short term has a direct impact on factory activity levels. In order to minimize the expense of operating plants at less than full capacity, we are pursuing multiple initiatives both to increase plant activity and to reduce plant overhead cost. These have included headcount reductions, for example, downsizing the formulation unit in excess, bringing outsourced processes in-house, consolidating activities and adding equipment to our plants so that we can carry out new cost absorbing activities.

There is a certain tension in all of this as you can appreciate. On the one hand we must be mindful of keeping plant costs to a minimum. On the other hand, our plants are critical to doing our business. We manufacture about 60% of our active ingredient and package or formulate much more. In addition, we have complex processes, a highly trained workforce and we operate in areas where there is fierce competition for employees. The fact is we will need these plants to be operating at full tilt in the future. In the meantime, we must be careful to preserve our assets.

Having said all of this I assure you that we are doing everything in our power to keep tight control on our operating expenses. Every function has been charged from the top down to reduce their cost, and yet continue to follow through on projects that we believe will add value to the company long-term. Year-to-date you will have seen we are operating at under 90% of last year’s expenses, however, we are not yet satisfied and we will continue to drive at this aspect of our business going forward.

On the subject of liquidity of our credit agreement, we covered the first amendment to our credit facility the agreement in the last call and by now, you may have read the Form 8-k on the matter. As I had mentioned on the last call we saw and received release from the consolidated funded debt ratio for a three quarter period, as well as the right to continue with uninterrupted dividend payments at the board’s discretion. Another important aspect is that the fundamental part of our business strategy is the acquisition of [Indiscernible].

Listeners to our previous call have asked whether our current financial performance has the impact of curtailing any possible acquisition. This is not the case. Our credit facility allows 3.25 EBITDA to be applied prospectively to any acquisition and furthermore contains significant additional borrowing capacity reserved for substantial acquisitions. What I am saying is that notwithstanding this tough period we are working through, we continue to look at acquisition candidates and have the capacity within the credit facility to go after those projects.

I have talked quite a lot about inventory, but I also wanted to briefly touch on a few other balance sheet and cash flow line items. Our debt is down in comparison to the end of the first quarter, but is elevated in comparison to the December 31, 2013 level. This increased level of debt is being driven primarily by inventory, and once we start to move those efforts through the balance sheet to receivables and then to cash, we expect working capital and debt to reduce.

Our receivables are a little higher than this time last year, despite the lower sales we discussed a moment ago. However, our sales this year have more international sales, which have longer terms. Overall, we believe that in addition to our anticipated cash flow from operations and having worked out from loosening of our key covenants for a few quarters. We have the necessary liquidity to work our way through this tough period, and additionally have the necessary dry powder in reserve if an attractive acquisition candidate is identified.

As the year progresses, we expect to see an increase in plant activity particularly during the fourth quarter. Also as we draw down AMVAC inventory and resume more normal plant activity and implement cost savings, this drive on profitability should lighten as we proceed into 2015.

Now back to Eric.

Eric G. Wintemute

Thank you, David. To conclude, we feel that renewed restocking demand for our corn products along with the proactive steps that we’re taking to enhance the manufacturing efficiency will allow American Vanguard to post rising revenues and a gradual recovery in our gross margin. Our balance sheet strength and credit availability are certainly adequate for the company to pursue additional growth opportunities. And we will continue to do so.

Now I will be happy to entertain any questions you may have. Royia?

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from the line of James Sheehan with SunTrust. Please proceed with your question.

James Sheehan - SunTrust Robinson Humphrey

Thank you. On the acquisition front, were you talking about new product lines, I appreciate all the color there, can you just give us a flavor for the pipeline of the types of new products that you might be interested in and, what the opportunity is there?

Eric G. Wintemute

Well, we – we do in two ways. One we are proactive and we go to, basically kind of the big six companies and ask them, if there is a particular product line we are interested in and so that sometimes works. More often we windup – they are doing their internal work and they are looking at products that, maybe are no longer core for them, and they write up perspectives and send them out and that is – that is probably 75% of the acquisitions that we get are done that way.

That being said, there are certain product lines where, we are targeted for the acquisition just based upon the past relationship and the ease of our – of making those transactions happen. Companies that are making these divestments typically, do not want to spend a great deal of time and resources making that divestment and the fact that we have had a very successful track record with them in the past does make us an ideal candidate. As far as activities, there are several products right now that we are looking at. So we’re happy to see some packages that have come across more recently.

James Sheehan - SunTrust Robinson Humphrey

Great, and you mentioned increasing international sales or at least maybe as a proportion, can you comment on what you are expecting over the next two or three years in terms of international sales and how the progression looks?

Eric G. Wintemute

Well, we are taking a much – one of the things that is required to expand our international sales I think is, getting registrations and getting kind of some of our product line registered into other countries. We have got a couple of activities in Brazil that we are looking at that Brazil has been a particular challenge for anybody trying to register their products there. But we have got – we got some shifts going on in Brazil that we are looking at and in addition Europe.

We have, of course, our SmartBlock product that did well in its initial year here in the United States, and we are expecting it to double for this next year. But the registrations in Europe should come in place in the first half of 2015. So we will start off there and we do believe that is probably the biggest market potential for the product overall. So that is kind of to name a few.

James Sheehan - SunTrust Robinson Humphrey

Are you targeting international as a priority for product acquisition?

Eric G. Wintemute

I wouldn’t say targeting as a priority, but we are in much better shape to I think value international today than we were prior to the last couple of years. A lot of that has to do with the structure, the way we are set up now, one, we have a broader base of both sales, marketing and infrastructure that we have set up in the Netherlands, and of course, in addition the fact that our tax rate on our international sales has dramatically dropped. It makes our international business much more exciting than maybe it had been in prior years.

James Sheehan - SunTrust Robinson Humphrey

Thank you very much.

Operator

Thank you. Our next question comes from the line of Brett Wong with Piper Jaffray. Please proceed with your question.

Brett Wong - Piper Jaffray

First thanks a lot for taking my questions. On the income statement there is a loss of $68 million, presumably from your investment in TyraTech and other JVs, I was wondering if you could talk to that and if it is because of those investments, are those investments meeting your internal expectations?

Eric G. Wintemute

Yes, I think it is $68,000.

Brett Wong - Piper Jaffray

Yes, sorry about that.

Eric G. Wintemute

Okay. You gave me a little heart attack. David?

David T. Johnson

I’m just taking that for $68 million for a second. What was the question?

Eric G. Wintemute

Well, I guess the question is, what is the –

David T. Johnson

Oh, right, and well, we have about 24% ownership position with TyraTech, and because we account for it on the equity method we need to take a portion of that estimated losses, a quarter of their estimated losses effectively. They are having a good year. They are heading towards profitability, but they still – we estimate based on analyst information, we estimate that our quarter was about $68,000 in the quarter.

Eric G. Wintemute

But it is kind of an exciting piece, because again it is a start-up company. It launched off their, in their personal care market they have launched off their head lice shampoo and treatment, and so far, they are tracking ahead of what their expectations were. So they seem to be picking up a lot of steam with that. In addition though they will be shortly launching their DEET kind of competition for mosquito repellent and that also looks very, very promising.

Brett Wong - Piper Jaffray

Okay, great. Thanks for the clarification and so I just scared you guys there, another one just with the grain prices where they are and the difficult inventory situation dealers got with this year, do you expect any slower order patterns from your distributors due to the uncertainty around crop selection?

Eric G. Wintemute

Well, I think, third-quarter we got a signal that we saw some modest increase in third quarter. We have positioned corn soil insecticides, when people were trying to get them as fast as they could in the third quarter and, more in the fourth quarter. So, I think we have – we will have a little bit in the third quarter, but probably not a lot. As far as the impact with – I think it is more a function of distribution still looking at, I mean our inventories on our products are down. I’m sure they have position on other corn products that are still lower overhangs.

But what we will do is we will have a retail stocking program that will be in place kind of in the fourth quarter and that will start driving – driving demand from our customers. So that is why we feel bullish on the fourth quarter upside.

Brett Wong - Piper Jaffray

Okay, and then in terms of kind of the opportunities that lay ahead of you guys, different regions, different crops, in this environment and kind of what you have been going through this year, can you talk to the priority right now if it is regional or you are looking at, soya beans here in the US, just kind of give us an update on that? Thanks.

Eric G. Wintemute

Just so I understand the question here. You are wondering what our priority is in terms of our existing product lines or growth of our product lines or from an acquisition standpoint?

Brett Wong - Piper Jaffray

It is more on the latter side, the growth opportunity, are there – you had just talked about previously new region opportunity in registrations in Brazil and Europe, I know you guys are also looking at other crops, I mean, where do those two things kind of sit in terms of your priorities and growth and obviously, being factored in the lower grain price environment?

Eric G. Wintemute

So, yes, I mean the lower grain price, let me just – let me just address that. We have – we have got the most extensive yield data I think of anybody over the last seven years because we started this project in 2007 season, and we have done, hundreds of field trials, every year we have gone through and we have mapped those, and again we were – pricing for corn was well under four dollars a bushel when we were showing healthy return on investment. As we looked at it, although I would say there is no doubt that as the price of corn came down, people looked at inputs and that is a natural type event. But we – across all of the corn belts, we are seeing better than 8 bushels per acre increase if you use one of our corn soil insecticide. Now if you chop that into what we presume are the high pressure areas, which is about a third of the field trials, we are seeing better than 20 bushels an acre increase, and so frankly from a return on investment it really is not, it is not a function of the price.

But that is a communication that we will have to continue to reinforce at this lower level. As far as, priorities, we are looking within we have what we call organic growth metrics, which is a number of projects and I think we have got about 48 active projects for expansion of use of our existing products. And those tie into both domestic, international and our non-crop function, and each one of those projects has a cross functional team that includes marketing and sales, and technical and regulatory and product development, and those are all on a timeline that, we will as they move through the process, we will be implementing, over the next – generally, they are within three years.

As far as looking at, specific projects and saying, I mean I know everybody would look at ours and say, I mean, I saw [Indiscernible] report and they were able to [Indiscernible] their liquid insecticide in the United States the upside in soya beans, and sure, we would love to have more activity in soya beans. That would also, help balance the idea that we were talking about of going into the southern hemisphere, also can help balance, and we are somewhat dependent on US weather patterns and how the crops grow.

So, we are looking to continue to diversify so that we have a better balance as we go forward. So I think that is about it.

Brett Wong - Piper Jaffray

Yes. That is great color there. Thank you very much.

Eric G. Wintemute

Sure.

Operator

Thank you. (Operator instructions) Our next question comes from the line of Daniel Rizzo with Sidoti & Company. Please proceed with your question.

Daniel Rizzo - Sidoti & Company

Hi guys.

Eric G. Wintemute

Hi.

Daniel Rizzo - Sidoti & Company

Just to go back to your comments on Terminix and how it is growing, do you have a timeframe when you think it is going to hit profitability?

Eric G. Wintemute

So the Terminix piece is with Envance and that was a different subject. I didn’t discuss, but Envance has expanded their stores from originally it was Home Depot, and they were about 1500 stores with Home Depot. They are now touching about 7000 stores, although both of – this year and last year have not been particularly strong for the home pest market. TyraTech, they are focusing on the personal care and again they are 40% owner of the Envance enterprise with us.

But they have their animal health business, which they are working with Novartis, and then they are kind of direct on the personal care, which are those two product lines. In there from what we see from the analyst position, I think they are kind of forecasting to be into – back into the profit centre in the 2015 year. So that is kind of the timeline with them.

Daniel Rizzo - Sidoti & Company

Okay, and then I’ll just, we have seen cotton prices really are you seeing – I mean, you said, I think you said that products from that segment were doing okay, whether you are seeing a softness because of I mean just in terms of cotton defoliants and herbicide, just given where prices have fallen to?

Eric G. Wintemute

No, I think the prices, have come down based upon USDA’s forecast of 98% of the acres are going to harvested, and that is kind of a record. West Texas usually has, a million, two or three acres that don’t get harvested, but this year they will. So we are seeing, good use of our cotton defoliant starting now in that market. So, that is an upside for us. In addition, our cotton insecticide Bidrin, we are seeing nice orders everyday coming in on that as well. So, I think, the crops in the ground, it is going to be harvested and our products are needed to make that happen.

Daniel Rizzo - Sidoti & Company

But have you seen in the past that when prices do fall that maybe growers are a little less reluctant or a little more reluctant, excuse me, to apply as much or buy as much product just because they are not getting the bang for the buck with the yield for acres?

Eric G. Wintemute

In terms of cotton, not in the year that it is occurring, obviously going into the year, for next year if cotton prices stay lower we will see probably a lower amount of acres planted. But at this point, we expect people will, will drive to protect their cotton and they will harvest it.

Daniel Rizzo - Sidoti & Company

Okay, thank you.

Operator

Thank you. (Operator instructions) Our next question comes from the line of Bruce Winter a private investor. Please proceed with your questions.

Bruce Winter - Private Investor

Hi, yes, thank you. I would like to see more information about your statement that your other products are performing well, on my list there were five and you have covered three, the cotton, the TyraTech and the SmartBlock. I was wondering as how the mosquito season for Dibrom is shaping up and PCNB, you are done with the EPA thing and any other products you can highlight for the back half of the year?

Eric G. Wintemute

Sure. So with mosquito, we are – that is a function of large, I mean there is always business that use mosquito control, but the big upside is the curve with the tropical storms/hurricanes that occur. And we have not had great storms that occur. We have that moisture and rainfall, which, lead to spraying. But the kind of spring that would encompass million, 2 million plus acres that hasn’t happened now. Typically that is kind of a September, October type event, although it does typically kind of kick off in August.

So we will see how that plays out. PCNB, we have recovered well in potatoes, and in the turf business we have got a couple of initiatives there. I mean, one, we have the traditional business that we have, which is for snow mold and that – those purchases will happen in kind of September, October. We have not regained the market share that we had prior to, but we have in those 49 projects, I think – there are I think 3 or 4 that are with PCNB. One of them we have come up with – I will call it a water-based PCNB that is, would have less phytotoxicity to grass.

Typically our product has been sprayed, just before the end of the season, before snowfall and really there is no concern about phytotoxicity, but there are three other sprays that occur for fungicides during the season, so one in kind of the early spring, one early summer, and then one kind of mid-summer. And so with this formulation we will have additional opportunity to expand our PCNB sales in the turf market. Also we have a couple of combination products, PCNB with a couple of different fungicides that we think will expand our ability to penetrate that market.

So on the one side we have lost a significant portion, on the other side is we are going back into the market. It has forced us to realize, where we could actually grow well beyond where we were before and those projects are underway. With regard to and I guess, yes, year-to-date I guess our sales are up 82% on PCNB so far. Naled, the Dibrom mosquito business, were up from just about 9% so far.

In our vegetable business, Dacthal, which our independent onion and other herbicides for other vegetables is doing very well right now. We’re tracking, we get a list of sales everyday and those seem to be – that probably seems to be doing very well. The – I’m trying to think what the other – Thimet, so our Thimet, which gets used both in peanuts and in sugarcane is also doing very well. So orders have been strong here and [Indiscernible] probably, so I guess, yes, in fact we are up 69% so far year to date on Thimet.

Bruce Winter - Private Investor

It sounds good. Another question, when you say that you manufacture 60% of your active ingredients, is that by weight or dollars in inventory and excluding the methane products, what would that number be and of the non-methane products, how sophisticated are you with manufacturing, do you do actual chemical reactions and separations to manufacture your products?

Eric G. Wintemute

Good question. The 60% means that if we had 10 active ingredients, we would be doing six of them. It is not by volume and I think we have got about 34, so 60% of that, is 20%, 24% range or somewhere in that range, 24 out of the 34. And then of course, as David mentioned, we also formulate and package a higher percentage of that.

Methane is actually relatively easy to make, but we have some molecules that are very complex. The PCMB facility itself, they make – only site in the world that makes PCMB. There have been others that have made it, but frankly to the quality level that we are at, I don’t know that we had anybody else kind of meet that quality level.

We have, our Aztec molecule, I think is relatively complicated to make. Again we are the only ones that make that in the world as well. So there – yes, these are, taking basic chemicals going through in some cases, several different steps of distillation and centrifuging from and that sort of thing. So, yes, it is very sophisticated.

Bruce Winter - Private Investor

And chemical reactions too?

Eric G. Wintemute

Yes.

Bruce Winter - Private Investor

Good. It sounds good. Thanks for taking my questions.

Eric G. Wintemute

Sure.

Operator

Thank you. At this time I would like to return the call to the management for closing remarks.

Eric G. Wintemute

Okay. Well, again, I wish we had better quarterly report, but we feel like we are – we are working our way through the best way that is possible to get us back to the numbers that we have seen in the past, and we thank you for your patience and your continued support. We look forward to talking with you at our next quarter conference call. Thank you.

Operator

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time and thank you for your participation.

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